Module 2 - Sources of Finance Flashcards
Matching (sources of finance)
The type of finance should broadly match the nature of its purpose e.g. long term funds for assets with a long life
Long term sources of finance
- ordinary share capital
- preference share capital
- bonds
Ordinary share capital
- equity
- permanent capital
- high level risk, high returns
- sole beneficiary of any upward shift in the market value of the firm
- no guaranteed minimum income or available return
5 ways of issuing ordinary share capital
- offer for sale
- offer for subscription
- placing
- rights issue
- crowdfunding
Offer for subscription
Allows the company to state in advance of the share issue that if the share issue does not raise enough money it will be aborted
Placing
Shares not offered to the general public but sold privately to selected investors - least expensive and common for small issues
Rights issue
Existing shareholders are offered opportunity to purchase further shares pro rate to their existing holding. Can sell right to third party.
Advantages of issuing equity share capital
- permanent capital
- flexible returns
Disadvantages of issuing equity share capital
- loss of control
- high costs
- non tax-deductible
Preference share capital
- not entitled to vote
- may or may not be listed on stock exchange
- usually fixed percentage of nominal value
- no guarantee of dividend
- paid before ordinary shares
- prior claim on assets in event of liquidation
Conditions that may be attached to preference shares
- cumulation
- redemption
- convertibility (at shareholder’s discretion)
- participation (in profits above a certain minimum)
Advantages of issuing preference share capital
- lack of dilution
- no loss of control over profits
- dividend doesn’t have to be paid
- alternative to debt
Disadvantages of issuing preference share capital
- high costs
- non-tax deductible
- expectation to pay
Reason for issuing bonds
a way for a company to raise finance through borrowing without going through a bank
Floating rate on bonds
Charged at a set margin over a base rate such as LIBOR
Bonds
- may or may not be listed on stock exchange
- can be credit rated
- commonly interest bearing
- must be paid before dividends
- fixed or floating interest
Advantages of issuing bonds
- cost (cheaper to issue debt capital)
- tax deductible interest payments
Disadvantages of issuing bonds
- security (some bonds are secured)
- lack of flexibility
Medium term sources of finance
- term loans
- hire purchase
- lease contracts
- venture capital
- business angels
Term loans
- typically obtained from banks for a few years
- repayable in a fixed pattern - not necessarily equal instalments
- secured by a fixed or floating charge
- likely to impose covenants
- interest charged at a fixed or floating rate
- default if payment is missed and ban can demand immediate full repayment
Hire purchase
- purchase and own and asset but allow the hiree to use the asset in return for regular payments
- charge a fixed interest rate on capital sum effectively borrowed
- equal periodic payments over life of agreement
- at the end ownership passes to hiree
Lease contracts
- obtain the right to use assets
- lessor (provider of the asset
- lessee (user of asset)
- debt finance
- lessor retains ownership
- all risks and rewards of ownership other than legal title
- if short term no right to use capitalisation
Reasons for leasing
- not enough funds
- asset regularly superseded
- security of a lease is limited to asset held under lease
- interest payments on leases are tax deductible
Venture capital
- new or expanding companies can obtain funding from a venture capitalist
- high risk high return
- provides funds in return for stake
- usually 3-5 years
- can be equity or debt or both
- usually a member of staff appointed to board
Business angels
- wealthy individuals
- usually have business expertise
- invest money in new or expanding companies in return for shares
- usually willing to invest earlier than venture capitalist
- assist business with expertise
- invest medium term then exit
Short term sources of finance
- overdraft
2. factoring
Overdraft
- loan facility on bank current account
- interest payable on amount overdrawn
- cheap way to finance fluctuating requirement
- expensive for long term borrowing
- repayable on demand
Factoring
- Provision of finance (80% of invoice for fee)
- sales ledger admin (2% rev fee) - chases debtors
- credit insurance
